Friday, February 21, 2014

Need for emergency fund -- Response received

I got some feedback on my earlier post Need for emergency fund. This feedback/discussion was with my very good friends. I did not argue with them right away. The reason was simple: I got matter for another post :)

And the winner is:

1. "Viren, tell me how can a middle class person with home loan and car loan EMI, build an emergency fund" By AR.
My take: Ridiculous. I know your cash pattern. Here it is:
You go out for party once in two weeks. This would definitely cost you 3.5k per month. You lend your money to your friends and hesitate to ask it back. I know you are very good at heart. However, this kindness costs you around 1.5k per month. How about the picnics that you go? Would cost you around 1k per month. Total it costs you 6k per month. Yearly, it costs you 72k per month. Need I say more?

The 1st consolation prize:

2. "Viren, I agree with you completely. Emergency fund is absolutely essential. I liked your article. I too maintain my emergency in XYZ instrument. This instrument matures next week. I am planning to upgrade my phone. I really need Galaxy. As I said, this emergency fund really helps in such situations."
My take: My earlier post was complete waste :( Emergency fund is never to be utilised for phone upgrade, pc upgrade, buy tab, go on picnics, etc.... Go get dictionary and check the meaning of 'emergency'.

The 2nd consolation prize:

3. "Why can't I keep my emergency fund in equity mutual funds? Won't I get good returns if I am not supposed to touch it for long period? "
My take: Lovely. Standard deviation and market volatility might have fallen from their chairs laughing.

And the last consolation prize:

4. "Is it really necessary? I mean, I think you wrote that to increase the contents of your blog"
My take: Awesome. What would I get if you DO/DO NOT create emergency fund? I would have considered this response for post MF not via SIP, since this post was born out of personal conversation with my close friend and everybody would not be able to relate it. However, for emergency fund post, your comment is like what we have 'no ball' in cricket.

Prizes end here.

One of my very close friend requested for follow up on the earlier emergency post with more details on the instruments to be used. This was constructive and good. (@US: let me know if more details are needed)

1. SB Account: Saving bank account. Enough

2. FD/Auto-sweep: Bank people may also call it as Term Deposit as you deposit your money for some term i.e. period. It is also called as Fixed Deposit as you deposit fixed amount of money for fixed tenure at fixed interest rate. Hence, premature withdrawal would either attract penalty or loss of interest. Auto-sweep is the facility provided by many banks wherein we can define a certain threshold value of amount. If the money in SB account goes above the threshold then automatically excess cash is considered as FD. Example: you have salary of 30k. You mention the threshold as 20k. Now, at every first of month, you would get a FD of 10k
All banks offer more or less similar interest rate. SBI offers 8.75%, Vijaya offers 9 and so on. Senior citizens may get 0.25 - 0.5% extra ROI.
The best way to use FD as emergency fund is to divide the entire amount in small FDs. Example: you have 1 lakhs, get 4 FDs of 25k each.
Cons: Managing multiple FDs
Pros: If situation demands of 50k, you can simple break 2 FDs and get interest on other 2 FDs. If you have lump sum FD, you stand to loose interest on complete 1 lakh while your need was only of 50k.

3. Liquid Fund: These are the mutual funds which invest in money market instruments. These instruments are treasury bills, CDs and CPs. The maturity of these instruments are generally less than 91 days. This ensures liquidity and safety of the capital as well. If currently, you invest in particular MF, go for liquid fund of that AMC.
These funds do not have exit loads and you can get your money in T+2 days max in your account.

4. Arbitrage Fund: These funds take advantage of the arbitrage opportunity available. Pattu has given wonderful example for this fund:
Suppose price of a commodity is 10 rupees in Mumbai and the same commodity costs around 3 rupees in Thane. Then we can take arbitrage opportunity by buying from Thane and selling it at Mumbai with increased price. Tomorrow if price of that commodity becomes equal in Thane, I do not loose any thing. I simply do not buy it anymore. I then look for other commodities or other places.
These funds invest in forex, metals, commodities, etc..

5. Short term and ultra short term mutual fund: These are similar to Liquid Funds. However, they can invest in instruments with more than 91 days. They also have exit loads and hence may be little less liquid.

6. Debt Mutual Fund: This category is not recommended for emergency funds. However, since I had used it in my last article, I am writing few lines on it. These funds invest in FMPs, MIPs, Bank FDs, Treasury bills, CP, etc.. G-Bond fluctuation can destroy their performances.

Let me know if you find any of the information incorrect or partially true. I would be happy to correct it.


4 comments:

  1. Dear Viren, everything is good. Just a small correction - Sweeping FDs are not anew thing. Even in 2003-2004, ICICI bank was offering the same to almost all SB accounts at that time, although withdrew later on. :) I do have an old ICICI account hence know it personally. Can not comment for other banks as I was not a customer with other banks. Salary account was with IOB which was not even CBS at that time. If I recall right somewhere in 2006, post full CBS roll out SBI also started these sweeping FDs.

    Thanks

    Ashal

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    1. Thank you Ashal for sharing your experience....

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  2. Viren - Is this short term and Liquid Funds have limitations to Minimum investment amount Example - I heard that if short tenure of Mutual fund must be invested in some lacs only few thousands are not allowed.
    If common man has lac amount to keep it as emergency fund then i think FD is safest and best option than MF.

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    Replies
    1. Kaustubh - Yes, most AMCs have that condition of minimum amount on Liquid and Short term funds.....
      I think, its entirely personal choice of where we keep our emergency funds.... However, I do not see any risk in Liquid and Ultra/Short term funds....
      Btw, even bank FDs > 1 lakhs are subjected to risk (even though that risk is negligible)

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